Defaults on Federal Student Loans Decline

September 25, 2014

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The Education Department reported a drop in Americans
defaulting on their student loans, a development it attributed to an improving
economy and a surge in enrollment in federal debt-forgiveness programs. About
one in seven borrowers who left college or graduate school in the fiscal year
ended September 2011 had defaulted on their student loans within three years.
The official figure—13.7%—was down from the 14.7% rate for those who left
school in fiscal 2010.

Defaults among recent college grads and dropouts rose
steadily since the recession, reflecting high unemployment and growing
individual debt burdens. The decline could mean student debt burdens are easing
as the economy steadily improves and unemployment falls.

Still, the government's default measure vastly
underestimates the problem. The government considers people in default if they
have made no payments in 360 days. A broader measure by the New York Federal
Reserve—which accounts for all Americans with student loans—shows that roughly
one in four borrowers are at least 90 days behind on a payment.

The government uses the measure to sanction schools with
high default rates among former students, and the Education Department said it
would strip federal funding for 21 such institutions. But the Obama
administration also tweaked the policy this year so that some
institutions—including public schools—would avoid sanctions. That drew
criticism from for-profit schools and others who said officials were unevenly
enforcing federal rules.

An Education Department official said the policy change
applied to all schools equally and was designed to account for borrowers who
owed payments to multiple loan servicers contracted by the government. A small
share of borrowers makes payments to one servicer but not others, a possible
sign they aren't aware they have more than one. The administration excluded
those borrowers from being counted in the default numbers.

Historically, the government measured defaults within the
first two years of students leaving school, but it moved to a three-year rate
in recent years to get a broader picture of borrower outcomes. The Education
Department said this year's drop reflected the administration's efforts over
the past two years to enroll borrowers in so-called income-based repayment
plans, which set borrowers' payments at 10% of their discretionary income. The
plans promise to forgive debt after a set period—10 years for those in
nonprofit and government jobs, and 20 years for those in the private sector.

Enrollment in the plans has surged, thanks in part to a
continuing administration publicity campaign. As of June, the number had
swelled to 1.91 million Americans holding more than $101 billion in student
loans—nearly a 10th of all outstanding federal student debt. The number of borrowers
and debt covered roughly has doubled in the past year.

The administration says stemming student-loan defaults helps
not just individual borrowers but the economy because Americans who default
damage their credit and thus impede their ability to spend and borrow. But the
programs also carry long-term costs to the government, as any debt forgiven is
covered by taxpayers.

Some critics say the programs are largely helping graduate
students, who have high debt but also high incomes, and thus might not need the
aid. Research shows that the typical American who defaults on student loans has
a relatively small monthly payment compared to all borrowers, raising questions
about whether income-based programs can stem defaults significantly.